Outsourcing of Unilever

Introduction

Unilever was formed as a result of merger of two companies Lever Brothers of UK and Dutch Margarine of Holland in 1930. Since then Unilever has expanded into 100 countries all over the globe. Catering to almost every aspect of life everyday this company has emerged as one of the best Fast moving Consumer Goods Industry (FMCG) with P&G as the sole competitor. Dividing the functioning of this company into various division of Consultation, distribution, Operations, maintenance and finance analysis has been done as to what was the purpose of the outsourcing the activities to other global firms like IBM and Accenture to name a few.

This particular case has been chosen, as it is a little peculiar.

If Unilever is such a big company with hundreds of brands all over the world then what caused it to outsource to other companies instead of producing the products itself?

Unilever strictly follows a four-step approach to outsourcing:

* Prioritize- decides on which functions to outsource. It should be noted that the core competencies and strengths should be strictly kept within the firm.

* Select- Unilever as mentioned focuses on marketing and selling its brand names. Hence while deciding to eliminate it wanted to remove administration and monitoring while concentrating on its R&D.

* Trust- this is on of the key issues related to the successfully working. It is extremely essential that the parent company maintain full confidence in the outsourced company so that the latter cannot steal the business ideas and strategies.

* Monitor- Even if two firms have a history of working together business means no trusting without monitoring. Constant monitoring and checks have to be kept.

Global Business Revolution leading to Outsourcing

In the 1990’s several forces interacted to drive forward the global big business revolution. Liberalisation of trade, capital flows, privatisation, collapse of communism and advances in IT and migration were the main forces. Initially however even with all these advances the large FDI flows were between the developed countries. However as the time elapsed the countries and big firms took the advantages of the political economic scenes and the competitive advantages to move to the developed countries.(Nolan et Al, 2002)

The structure and functioning of R&D within large corporations has always been greatly influenced by the overall corporate structure. Particularly this has been associated with the trend away from a single structure to multi divisions. Hence even if a firm maintained entirely internalization it was hard to cope up with the specific needs of product divisions. This gradual structural changes in my large enterprises associated with the process of diversification has meant that the possible permutations of the R&D structure and functioning and consequently locational pattern within these firms would be more complex.(Howells, 1990)

When analyzing the theories and strategies followed by the company there are certain drivers, which have keenly influenced the decisions of Unilever. Unilever analysis has been done from the birth of the company in 1930 till date. After a thorough study the main factors were determined and have been expanded below in detail.

1. Transaction costs

According to (Coase, 1937) the definition of firm takes into consideration a number of factors. One of the major factors of a firm is the controlling of price mechanism. The direction in which the firm uses its resources is directly dependent on the price mechanism. This price mechanism includes the transaction costs borne by the firm. Within a single firm these transaction costs are not completely but greatly reduced. One of the major reasons for the big firms, which expand their products or capacity, is to eliminate these kinds of intra firm costs. The other important reason for the existence is the desire of some people to control but not to be controlled and to exercise power over others. Hence the entrepreneur carries out the function at less cost taking into account that the firm may get factors of production, which it supersedes, and the firm can always revert back to the open market if it fails to produce efficiently.

The exchange transaction costs on a market and the costs within a firm are also treated completely differently by the regulatory bodies. The market costs may involve the different types of taxes like sales tax while a firm involves quota schemes and other methods of price control. A firm of the scale of Unilever has lots of costs within a firm and has to take several decisions in order to balance the internal and external costs. On the one hand is whether it should internalize completely or completely outsource in order to specialize. Outsourcing completely would increase the costs to a great extent while internalizing completely would not give the most optimum quality. The best balance between the two has to be obtained in order to remain consistent with the aim and the long-term goals of the company.

Unilever initially concentrated on expanding its firm size by moving to different countries and increasing its product range. As we see today Unilever is a perfect balance between its initial internalization and tremendous outsourcing.

Another dimension is that the welfare gains can take place where a new market is created which never existed before. Welfare losses however arise when the multinationals maximize monopoly profits by restricting the output of goods and services. A firm following internationalization allows more cross-functional and inter plant integration and in the long term this can stimulate both R&D and its effective integration in production and marketing. Unilever’s strategy can be considered with regard to this aspect from its formation in 1930 till around 1970 Unilever focused on internalization. During this period they focused on improving its R&D, production, marketing and expanding all across the globe.(Buckley, 1990)

2. Strategic decision and control

According to Buckeley (1990) the long run nature of internationalization cannot exclude the competitive advantages a firm possesses which may in the future be imitated by its competitors. These internationalization benefits can only exist in imperfectly markets. For Unilever the internationalization of R&D and other process would become obsolete in the long run. Utmost care should be taken to distinguish these long run benefits and cost of internalized R&D units from competitive short run advantages by the technological lead.

Further while the expansion of Unilever continued internationalization of markets across the international frontiers allowed the reduction of the firm’s overall tax bill relative to other firms, which traded. It proved to be a strategic weapon against firm in some strategies. However over time analyzing the reality and the relative simplicity was an issue of concern. This trade off had to vary depending on the task in hand and the condition of the markets.

Buckeley (1988)

The general statement that the imperfect markets will be internalized till the benefits equal the costs have to be restricted by defining costs and benefits in relation to particular markets at specific points of time and across the economic space. Although the cost of internalization of a firm is a strategic decision to increase profits however a number of conflicting views have come up by economists. This theory has unconventional cases like those involving foreign direct investment. Increased changes in social and political conditions, technology and techniques, tastes and demand patterns have an impact upon the division of labor and the various costs conditions involved. This new division of labor is increasingly leading to a vertically integrated structure. The vertical structure in turn is leading to a multi plant operation and intra firm trade. This combination of internalization pressures and location of costs results in new division of the industry each specializing in its own area. However this is not a global strategy. This strategy is constrained by a value chain and the various coordination issues. Unilever, which also as mentioned above following the internalization in the early years now focuses on outsourcing.

Outsourcing which is mainly the international division of labor is of the key strategies followed by the firms to focus on their competencies whilst giving contracts to other firms for other departments. (Buckley, 1988)

Hymer’s theory brought to the world the concept of international operations of national firms. Many firms aiming to expand worldwide are doing so by the process of International Investment. This international investment can be categorized into International Portfolio investment and foreign direct investment (FDI).(pg 21)

Unilever main area of focus is the foreign direct investments.

Again the FDI can take place by direct flow of cash or by franchising, licensing, Alliances, joint ventures and subcontracts. Unilever uses a combination of these to expand. For example in China (pg 57) because of entry issues it focused on joint ventures. These are contrary to Buckley’s theory of internationalization, which saves the costs. However when we consider the first major determinant of Hymer’s theory of specific advantage we see that Unilever’s outsourcing policy is directly related to it. The specific advantage policy explains that exploitations in the market and imperfections in foreign markets give a competitive advantage to the firm. When Unilever had to expand in India they did so by collaborating with a number of partners in different fields. Although this increased theoretically transaction costs the ease with which it established itself, as a brand would have taken a very long time otherwise. Certain incidents like these of India and China brought to light the fact that the firm had been realizing that only internalization will definitely not be enough.

Taking a note of these various reasons as to why Unilever, which initially focused on internalization, would now focus on externalization or outsourcing. Some analysts believe that dividing the work to companies, which specialize in it, would have lower costs for the same goods than the cost at which the company produces it. This would be striking the balance with the transaction costs and the costs of internalization. However a survey done shows that only 29% of the people consider the cost reduction factor. A major factor is the quality of the finished products. Outsourcing will increase the organization’s access to a range of experts and specialists. It is usually hard for a big firm like Unilever to keep track of advancements in every field of operation. Outsourcing certain functions would help it to respond quickly to changing market demand and supply. Hence the company to maintain its quality standards would rather divide it among other companies.

3. Outsourcing and Advances in ICT

(Kim and Ummnath 2005, cited in Yamin and Sinkovics 2007) see technological breakthrough in independent partnerships since it radically changes the technological landscape partners and allows partners to exploit ICT capabilities. Gradually the federative system is becoming extinct and people are moving more towards outsourcing. This basically has two dimensions- the disintegration of subsidiary value chains and growth of outsourcing due to increasing modulation and increasing ICT systems. A wholesome integration of the company is developed since the process involves electronic integration. Electronic integration includes a variety like coordination of decision and operation integration, mutual investment in relationship specific assets, information sharing and monitoring control.

Unilever follows this strategy exactly in the same manner by establishing one of the biggest contracts with IBM. Unilever in relation with this theory has decided to sign a long-term seven-year contract to transform its financial services in Europe. Unilever believes that this will provide “long term benefits for Unilever” and is “a strong example of the new on demand business in IBM is targeting in the marketplace for business performance transformation services”, IBM said.(silicon.com)

However this particular case of Unilever is quite striking. It has contracts with some of the biggest and equally powerful company in the world. According to (ICT) it was believed that enabling such a great control in the MNE’s the company may be at a risk and this may reduce the long-term viability. Care has to be often taken in such a manner that the company doesn’t start losing its business to companies to which the job has been outsourced. Sometimes care has often been taken to first establish trust by building a short-term contract and then extending it. Often Unilever has also maintained full control of its business by sending some people from Unilever to HP so that the internal functioning of the company and the data is kept intact.

Apart from the ICT there is often a discussion about MNC on exploitation and exploration. Exploitation refers to the utilization, refinement and extension of the existing capabilities while exploration refers to creating the adaptive capabilities of the organization. In most companies “exploitation drives out exploration”(Ahuja et Al, 2001). Unilever while following the exploitation also took steps to ensure that exploration is also moving hand in hand. This is very apparent from the company product expansions. While at some point it was trying to improve its products and innovations by exploitation its existing technologies and in other countries it was establish market efficiency by collaborating or making contracts with market leaders in the same company.

4.Outsourcing Innovation

The results from Unilever further provide supports to the view that decentralization of innovation enhances the overall innovative role of MNEs. Yamin and Otto (2004) found that internal and external knowledge flows have a complementary and reinforcing positive impact on innovative performance. The performance of some products that had been acquired, it was obvious that external connections were key to highly profitable future innovations. As Hymer put it ‘decentralization within a corporation is often not the opposite of centralization, but the complement. This was again directly related to gaining the expertise in a particular subject by reducing the costs of the firm’s staff and R&D and acquiring it from another firm excelling in it.

Conclusion

It is very evident from this particular case study that the firm has very strategically followed a growth path in accordance with the main theory of Hymer. In short Unilever slowly moved from internalization to externalization. This change was brought about gradually and was to the advantage of the company in the long run. The outsourcing was important to increase knowledge at the extra costs but also a strong trust had to be established between the two. The contracts had to be carefully established so as not to disclose the internal company strategies whilst trying to establish complete knowledge in the outsourced department. Extra care has to be taken for companies like Unilever where even the outsourced companies were as massive as the parent company. Unilever even today is putting its utmost focus on expanding its core competencies to perfection and serve the finest quality of products and services to its customers. Unilever with its strategies has indeed established a unique brand name all over the world and this has indeed been made possible by outsourcing also to some of the finest companies. It can also be noted that though Unilever outsources to IBM it also outsources to other medium scale firms of IT. Personally I feel this helps to keep a constant check on their services. This perfect balance, trust, coordination and flow of information between the two companies have made it possible to sign deals worth millions. The work done by Coase, Buckeley and Yamin has indeed been very significant and it has been possible to relate it directly to the actions of the companies at the various stages of the growth of the company.

References:

Buckeley, P.(1988) The limits of Explanation: Testing the Internationalization Theory of Multinational Enterprise. University of Bradford

Buckeley, P.(1990) Problems and Developments in the core of International Business.Ph.D. University of Bradford

Coase, R.(1937) The Nature of the Firm. Available from: (source missing)

Yamin, M and Sinkovics, R. (2007) ICT and MNE reorganization: the paradox of control. Manchester Business School